Reserve Bank of Australia Bulletin
May 2000
Box C: Margin Lending
In recent years household borrowing to
finance investment in the share market has
increased. Some of this has been through
personal loans and loans secured against
houses and, therefore, the amount of such
activity is not easily measurable. Some of
the lending, however, has been more direct,
taking the form of ‘margin lending’. Margin
loans involve the borrower lodging cash or
shares with the lender (typically a bank or
stockbroker), which then supplements the
investor’s capital by providing a line of
credit. This line of credit – the margin loan –
plus the borrower’s own capital are used to
purchase shares, which then become the
security for the loan. Margin loans have been
available in Australia since the late 1970s,
although they have increased strongly in
recent years as most retail banks and larger
stockbrokers now offer this product.
Margin loans outstanding from banks and
brokers rose from $2 billion in
September 1996, when the Reserve Bank
began informally collecting this information,
to $6.3 billion in the March quarter of 2000.
Over the past year, margin lending has
increased by 50 per cent, although there are
some signs that this growth might have
begun to slow following the absorption of
the Telstra 2 sale. Interest rates on margin
loans are currently around 8.4 per cent,
about 0.7 of a percentage point higher than
for a residentially-secured line of credit, but
almost 2 percentage points below the
interest rates available on other secured
personal loans. Fast growth in margin
lending over recent years mirror s
developments overseas. For example, over
the year to March 2000, margin lending in
the US grew by 78 per cent.
While the recent rate of growth of margin
lending in Australia has been high, the level
of margin debt remains relatively low. The
value of outstanding margin loans represents
about 0.9 per cent of market capitalisation
of the Australian Stock Exchange, around
1 per cent of GDP and 1.3 per cent of the
household sector’s gross liabilities. These
figures are well below those for the US
(Graph C1). The level of margin loans is
not thought to pose any significant
prudential risk to the individual lenders
involved, or systemic risk for the financial
system as a whole, given that they account
for such a small part of total lending.
Whether margin loans will adversely affect
the share market in the event of a market
correction is, however, less clear.
Graph C1
Margin Debt Outstanding
As at December 1999
%
3.0
2.5
%
3.0
Australia
United States
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
As a per cent
of market
capitalisation
As a
per cent
of GDP
As a per cent
of household
liabilities
0.0
Leverage and risk
By leveraging their own capital with a
margin loan, it is possible for investors to
control a much larger portfolio than they
could if they were to invest only their own
capital. Leverage, however, magnifies both
the potential gains and losses that might
result from fluctuations in equity prices (see
example below).
Financial institutions typically designate
the range of securities which they are
prepared to accept as collateral in order to
limit their potential exposure to investors
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Semi-Annual Statement on Monetary Policy
with margin loans. In Australia, lenders also
typically limit the funding from margin
loans to a maximum of 70 per cent of a
portfolio of ‘blue-chip’ stocks; a larger
equity contribution would be required of
investors buying other securities.
Larger margin lenders in Australia say
that Australian borrowers typically gear
their portfolios conservatively, providing
around 50 per cent of funds from their own
resources. This operates to minimise
investors’ exposure to market volatility,
particularly the risk of receiving a margin
call. Banks and brokers make margin calls
when falling share prices result in the
Example: The effects of leverage
Initial portfolio value: $100 000
Investor’s equity contribution: $30 000
Margin loan: $70 000
Maximum gearing ratio prescribed by the
lender: 70 per cent
Case 1: Market value of portfolio
rises by 10 per cent
New portfolio value: $110 000
Gearing ratio: 63.6 per cent ($70 000/
$110 000)
Return on investor’s equity: 33.3 per cent
($10 000/$30 000)
In the absence of the margin loan, the investor’s
return would have been 10 per cent, the same as
the rise in the market value of the portfolio. To the
extent that the investor still has unused margin
credit available, the investor could purchase up to
about an additional $23 000 of shares, to restore
the gearing ratio to 70 per cent.
This would tend to reinforce buying pressure in
the market.
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May 2000
market value of a borrower’s equity falling
below the minimum level prescribed by the
lender (see Case 2 in example).
When a margin call is made, borrowers
must restore, within 24 hours, their gearing
to the ratio required by the lender.
Borrowers can provide additional equity (in
the form of cash or approved securities) or
instruct their lender to sell some shares
from the portfolio and use the proceeds to
repay part of the debt. If they fail to take
either of these courses of action, the lender
has the power to sell sufficient securities to
restore the required ratio. R
Case 2: Market value of portfolio
falls by 10 per cent
New portfolio value: $90 000
Gearing ratio: 77.8 per cent ($70 000/
$90 000)
Return on investor’s equity: –33.3 per cent
With the gearing ratio exceeding the prescribed
maximum, a margin call is triggered, with the
investor required to restore the gearing ratio to
70 per cent. The investor could do this in one of
three ways:
• Paying a minimum of $7 000 in cash, thereby
reducing the loan to $63 000.
• Providing the equivalent of at least $10 000
extra in approved securities, restoring the
portfolio to its initial value of $100 000, with
a loan of $70 000.
• Selling about $23 000 in shares out of the
leveraged portfolio, and using the proceeds to
repay the debt. This would leave the investor
with a portfolio valued at about $67 000, a
loan of $47 000 and investor’s equity of
$20 000. This sale of shares is larger than the
margin call in cash or securities because, as
the investor’s equity has been reduced to
$20 000 by the decline in the market value of
the portfolio, the maximum loan size this will
support is about $47 000. Therefore, if the
investor was not willing to top up the equity in
the portfolio, the investor would have to sell
enough shares (i.e. about $23 000) to raise
cash to reduce the loan to this level.